Sub-prime ministering

Abbey is set to re-enter the sub-prime market in a tie-up with investment bank Merrill Lynch just four years after it sold its sub-prime brand First National to GE Consumer Finance.

It has yet to confirm its plans but industry sources believe the bank has signed a deal with Merrills that will see it distribute buyto-let, self-cert and sub-prime mortgages.

The deal is expected to follow the same set-up as Alliance & Leicester’s partnership with Lehman Brothers, confirmed last June, which sees Lehman buy assets from the loans.

John Charcol senior technical director Ray Boulger says: “There has been some talk about Abbey entering the sub-prime market for months now so I am not surprised it has done it. The bigger surprise for me was that it sold off First National to start with. This was at a time when other lenders were moving into sub-prime so it was a bit odd.”

Mortgageforce managing director Rob Clifford says: “Merrill Lynch is a hugely successful international bank and knows all about pricing for risk. I think partnering with a specialist is a cute way of doing sub-prime business and it gets you to market quickly.”

Boulger says: “I think most lenders choose to start off with this option in order to play it safe and not take on the risk but I think once it gets a feel for the market it will then decide to transfer some of the risks on to its own balance sheet.”

He points out that as Abbey used to own First National, it was comfortable to have these types of risks on its balance sheet.

A&L has confirmed it will be taking BTL business on to its own balance sheet in the coming year, with the rest of the business staying with Lehman. Spokeswoman Sally Lauder says it was always A&L’s intention to do this but insists the lender will continue to have a good relationship with Lehman with regard to the rest of its sub-prime business.

Homeowners Mortgages chief executive Mark Chilton says he is surprised Abbey did not decide to go it alone from the start. He says: “It will be very difficult to differentiate its offerings from the other brands that Merrill Lynch owns such as Mortgages Plc and Freedom Lending. Abbey’s product will just be one more chain in the distribution loop. The biggest attribute will be what it can do through its branch network.”

It is not yet known if Abbey will look to build a specialist lender or use Mortgages Plc as a distribution platform.

Edeus chief executive Michael Bolton says he welcomes the competition and awaits details of the proposition. He says: “Given the time and resource we have got, for Abbey to launch into the specialist mortgage market will not be easy. With our model, we have established the benchmark and it will be hard for it to compete.”

Clifford says there are three things lenders must do to gain market share where they do not have historic recognition. He says: “First, lenders need to think about product design, making sure they have attractive lending criteria. The second factor is pricing – not just that you are competitive against other lenders but that you also get the risk price right. Last of all, you need to have control of distribution.”

Clifford says lenders have to get one or all of the factors right to succeed and notes that GMAC-RFC has been the most successful in getting them all right.

Boulger says Abbey is effectively doing the same as GMAC by putting very little on its balance sheet. He says: “The difference is that GMAC’s model is for the long term while Abbey is likely to be only doing it for an initial period only.”

Most of the top 20 lenders have now entered the sub-prime market, with only a few notable exceptions including Barclays/Woolwich and Royal Bank of Scotland. Chilton believes Barclays will follow but says he does not know in what form.

Clifford says margin pressure means Barclays will have to consider sub-prime business. He adds: “Lenders tend to get pigeon-holed into certain categories. I do not know whether Northern Rock, A&L and Abbey will make the grade with brokers accepting them for specialist business over those firms which only do this business. Their operational delivery will need to be great to help them succeed.”

Chilton says watching Merrill Lynch is very interesting at the moment, pointing out that it is making a big land grab in this sector and pursuing it actively.

Boulger says: “A lot of new entrants into the market are being funded by Lehman Brothers and Merrill Lynch. Merrill Lynch has been quite aggressive in the mortgage industry already and it is expanding quite rapidly. The danger for it will be if we see property prices in the UK start to fall.”

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